161st mBank-CASE seminar: Trade wars and the rules of competition in global trade

The subject of the 161st mBank-CASE seminar was contemporary trade wars and their implications for the European Union and Poland. The trade war with China launched in March 2018 by U.S. President Donald Trump has significant implications for the entire global economy, and is causing collateral damage to the EU. There is a justified fear that America’s current trade policy can lead to the collapse of the multilateral order in global trade and a return to a system based on bilateral agreements. Presentations on the current trade war and its various consequences were delivered at the seminar by Professor Jan Jakub Michałek of the Faculty of Economic Sciences at the University of Warsaw and Dr. Przemysław Woźniak from the European Commission’s Directorate General for Economic and Financial Affairs

Trade war?

According to Professor Michałek, the origin of the trade war is simple: The U.S. has a global trade deficit ($890 billion in 2018), and China is responsible for half of this amount. But the deficit is nothing new. On the contrary, the U.S. trade deficit has been growing for years, and was already at a very high level for example in 2007-2008. It’s also worth stressing that when it comes to trade in services, the U.S. has a surplus. America has its largest trade deficit in the following product groups: computers, electronics, electrical equipment and other industrial products. Its main export products, in turn, are transportation equipment, computers and electronics. These are the sectors that will be most strongly hit by the current tariff increases.

The conflict we are witnessing began in 2017, when Trump asked for an analysis of whether aluminum and steel imports constituted a threat to U.S. national security. About a year later, a report was prepared which said that they did. It also included a comment that “trade wars are good, and easy to win,” which unnerved many liberal economists who work on international trade. In March 2018 the U.S. increased tariffs on steel and aluminum, and later on many other groups of products.

The legal basis for Trump’s actions is, first of all, Section 232 of the 1962 Trade Expansion Act, which says imports can be limited if they threaten national security. Secondly, the U.S. refers to Section 301 of the 1974 U.S. Trade Act, which gives the president the authority to make all possible efforts, including retaliatory action, if the policy of a foreign government violates international law or is unjustified, unreasonable or discriminatory and burdens or restricts American trade. The U.S. says that China is violating intellectual property rights and engaging in dishonest competitive practices. In response, China introduced retaliatory tariffs, although their scale was smaller – which results partly from the simple fact that exports from the U.S. to China are significantly smaller than in the opposite direction.

Prof. Michałek pointed out that GATT rules are significantly more restrictive than domestic American law. WTO member countries sign lists in which on the basis of Article 2 they commit not to increase customs duties on other GATT and WTO members. These lists indicate that almost all the Chinese and U.S. tariffs are related, which means that the countries don’t have the right to increase duties. Simultaneously, and significantly, the weighted average import duty in the U.S. is 2.3%, i.e. very low; in China it’s 4.8% – also low, but higher than in the U.S. The difference arises because China joined the WTO later and negotiated customs duties from the position of a developing country, so it was allowed to keep higher rates. GATT-WTO rules allow tariff increases in two cases: If there is a threat to the interests of domestic industry, or for national security. Prof. Michałek stressed the significance of how until now, these regulations have been applied only in the case of certain sensitive goods, such as arms, but not in the context in which the U.S. is now trying to use them, setting a very important precedent.

Next, Prof. Michałek moved to a discussion of the findings of selected academic research related to the subject of the seminar. First he presented a paper by Bellory & Fontagne (“Shooting oneself in the foot? Trade war and global value chains”, 2019), in which the authors used a general equilibrium model to research the consequences of the restrictions introduced by the U.S. and the retaliatory actions (as of July 2019). A direct result of the introduction of the tariffs is additional fiscal income in the amount of $103 billion in the U.S. and $8.6 billion in China. But U.S. exports in turn fell by 5.97%, and China’s by 3.09%. Another result is a drop in U.S. GDP by 0.28%, and China’s by 0.39%. These results are consistent with those of most other studies on the issue. The model predicts a strong drop in U.S. exports to China and an even stronger one in the opposite direction. Significantly, a large part of Chinese exports to the U.S. consists of intermediate goods, which are later used in the U.S. to make final products, meaning value chains are destroyed. Next, Professor Michałek briefly presented contemporary theories of trade wars and estimates of their results. Research using Nash equilibrium indicates growth in tariffs in a state of equilibrium in a range from 4-5% to 70-80%. The high variance arises because various functions can be used in the model for the government’s goals. In particular, a government may place greater or lesser weight on the general level of welfare and on the interests of lobbyists representing particular sectors of the economy. The greater the weight placed on the interests of lobbyists, the higher the level of tariffs in conditions of equilibrium.

At the end of his presentation, Professor Michałek showed a chart presenting the evolution of international trade during the Great Depression in 1929-1933. Global production fell by 30%, and international trade shrank by almost two-thirds, which was related directly to an escalation of trade wars. Conclusions were drawn from this experience; a global trade system was created based on multilateral agreements, and the International Monetary Fund, the World Bank, the GATT and the WTO were set up. Professor Michałek concluded by asking whether Trump’s policy will lead to the dismantling of this system and the end of an era in international trade.

Trade war: the European perspective

Dr. Woźniak began his presentation by showing the dynamics of growth in global foreign trade. The indicator of trade intensity (exports and imports/GDP) grew from 8% in 1960 to just over 25% in 2015, while achieving its highest growth rate in 1987-2007 (an average of 0.7 percentage points a year). However, in recent years we have been observing a slowing of this tendency: growth in trade intensity has fallen from 1.7 in 2001-2005 to 0.9 in 2011-2015, and a further decline is expected. The unprecedented growth in the value of global trade was a result of far-reaching liberalization, including tariff reductions, China’s entry to the WTO and several expansions of the European Union. The average level of tariffs fell in 1990-2010 from close to 40% to less than 10% in the case of developing countries, and from close to 5% to about 2.5% in developed countries. Another very important change was the dynamic development of global value chains. Dr. Woźniak pointed out that the EU, China and Japan are much more strongly “entangled” in global value chains than the U.S., which is more oriented toward its internal market.

According to Dr. Woźniak, some of the decline being observed at the moment may be explained by fast economic growth in developing countries (primarily India and China), which are less open to trade than developed ones. Other causes are shifts in the structure of GDP (including primarily a drop in investment and shifts from the goods sector to services), a slowdown in the growth of global value changes (or in fact their shrinkage) and a slowdown in the liberalization process. What’s more, these processes are combined with a slowdown in the global economy, which may intensify their effects. Trade wars increase uncertainty, particularly related to possible departures from the current order in global trade, which has a negative effect not only on international trade but also on investments (primarily in the manufacturing sector). Dr. Woźniak also presented the European Commission’s simulations of the effects of increasing tariffs by an average of 2% around the world, using a general equilibrium model. This model indicates a decline of 0.2% in GDP in the EU and the U.S., 0.3-0.4% in China and about 0.15% in the rest of the world. Dr. Woźniak also pointed out that the EU’s response to the outbreak of the trade war between the U.S. and China is the greater activity in negotiating bilateral trade agreements with many countries, including the members of Mercosur (South America), Mexico, Australia and New Zealand (earlier, agreements took effect with countries including Canada and Japan).

Discussion

After the panelists finished their presentations, the floor was opened to the audience. Questions raised during the discussion included: the significance of the position of the U.S. dollar as a global settlement currency and its effect on the U.S. trade deficit; China’s violation of intellectual property rights and state subsidies for Chinese industry; geopolitical issues that could be the cause of some of the American administration’s actions; the American moves in the context of WTO rules; the weakening of the WTO’s position by the Trump administration; the uneven distribution of the effects of the trade war on particular sectors of the economy; currency wars; the competitiveness of the American economy at the microeconomic level; and the reaction of the EU to the outbreak of the trade war.

Author: Łukasz Janikowski